Examining the impacts of FDI on the wage premium of skilled labor

Abstract

This paper examines whether foreign direct investment (FDI) is an important contributing factor to the rising wage inequality between skilled and unskilled labor in the selected OECD countries. While numerous studies in the extant literature (e.g. Sachs and Shatz (1996), Bernard and Jensen (1997)) have examined the impacts of trade on wage inequality, few have studied the impacts of FDI on it. One distinct difference between trade and FDI is that while trade in the service sectors (which is generally more skill intensive) is small, FDI in the service sectors is relatively much larger. For this reason, one important bias caused by the omission of FDI from the study is the underestimation of the impact of globalization activities on the wage differential across industries with diverse skill intensities. Since inward FDI makes use of the labor inputs in the destination countries, it has a direct impact on the labor demand and wages in those countries. In view of this gap in the current literature, the contribution of this study is twofold. First, it uses industry level FDI, wage and skill-intensity data from five OECD countries to examine the relationship between the sectoral composition of FDI and the wage premium of the skilled labor. It is found that inward FDI that concentrates on the skill-intensive industries tends to drive up the wage premium. Second, this paper employs a simultaneous system model that takes into account the interrelationship between trade, FDI and wage premium. The results indicate that the skill intensities of the inward FDI play an important role in the determination of the wage premium even after the effects of trade are accounted for.